End of the Oil Age: Not whether but when

Reda Cherif and Fuad Hasanov are Senior Economists at the International Monetary Fund (IMF).

Aasim M. Husain is currently Deputy Director in the Middle East and Central Asia Department (MCD) of the IMF.

A transportation revolution is underway that could completely transform the oil market in the coming decades.

When oil prices suddenly halved from over $100 a barrel in 2014, our IMF study concluded that supply-side factors such as the emergence of shale and new technologies would be a key force keeping oil prices “lower for longer.” More recent studies suggest that other new technologies, such as the spread of electric cars and solar electricity generation, could even more profoundly affect the oil market and the long-term demand for oil. As Sheikh Zaki Yamani, a former Saudi oil minister, once said, “The stone age came to an end not for a lack of stones, and the oil age will end, but not for a lack of oil.”

A hundred years ago, coal accounted for close to 80 percent of US energy consumption. Within 20 years, that share fell to one-half, and within 40 years to only one-fifth as oil displaced coal as the world’s main energy source. This happened even though coal was cheaper than oil, because there was no real alternative to power motor vehicles, which quickly went from an exotic luxury to the preferred means of personal transportation. Today, automobiles account for about 45 percent of oil consumption in the world.

Image Courtesy: As provided by the author

With the rise of electric vehicles and renewable energy, the world may be on the verge of a revolution in transportation and energy technology that could transform the oil market the way the coal market was transformed a century ago. Like coal then, oil could see its share in energy demand plummet in the coming decades.

The year 1917—when Ford first sold a mass-produced, affordable vehicle—was a tipping point. Electric vehicles may be about to hit a similar tipping point: several companies are starting to offer models for about $35,000, roughly the average price of a new motor vehicle in the United States today. With their much lower maintenance and fuel costs, it is hard to deny that electric vehicles could displace a sizable number of motor vehicles in the not-too-distant future. The question might be not so much “whether” as “when.”

Image Courtesy: As provided by the author

Drawing from the experience of the displacement of horses by motor vehicles in the early 20th century, our recent IMF working paper predicts that electric cars could represent 90 percent of the stock of cars in advanced economies and more than half in emerging market economies by 2040. Others also predict a sizable displacement of motor vehicles, albeit at a slower pace.

But wouldn’t an increase in demand for electricity to power these vehicles give a boost to the market for oil to run generating plants? Not really. Oil’s share of the market for electricity generation and heating is already less than 20 percent globally, and that could shrink further because of the rise of another new technology: renewable energy.

Renewables have also witnessed revolutionary development in the past decade. The cost of producing electricity from solar power has fallen by 80 percent since 2008 and from wind power by 60 percent. Unsubsidized solar and wind energy, already competitive in 30 countries, is projected by the World Economic Forum to become cheaper than coal and natural gas in more than 60 percent of the world in the next few years. Even without further technological advances, the penetration of renewables will spread as capacity investments already underway are completed.

Whether renewables and electric vehicles spread as rapidly as predicted, over the next 20 years they will crowd out the demand for oil substantially. And if climate change concerns intensify, the transformation of the world oil market could be even faster. Even more so if other new technologies, like fuel cells, hydrogen-based power generation, ride sharing, and autonomous driving also take off. So even though it is hard to say which way oil prices will go next week or next month, by 2040 oil will be much cheaper than it is today, and the equivalent of $50 a barrel might seem impossibly high then.

With that outlook, it is no surprise that oil producers and automakers are getting ready for the end of the oil age. Many car companies are investing heavily in electric vehicle technologies—the recent announcement by Volvo that all its models will have electric motors by 2019 is an example. Similarly, many oil-exporting countries, which rely on oil revenue to finance government programs and generate jobs, have wisely launched wide-ranging diversification drives to ready their economies for cheaper oil.